Valuations
The first thing to look at is valuations, which have clearly run up.
Pat Ryan, manager of the Lazard Global Equity Income Fund is in the bull camp when it comes to continental Europe, but admits that valuations are not as attractive as they once were. He sees the region lying somewhere in between the overvaluation evident in the US and the undervaluation present within emerging markets.
“At a price earnings ratio around 17 times, the market is not as compelling, but it is still cheaper than the US and, importantly, unlike the US, earnings remain 30% below their previous peak,” Ryan said, adding, “If the region can produce a recovery, earnings could grow by double digits in Europe for a couple years.”
Michael Barakos, CIO for European Equities at J.P. Morgan Asset Management agrees that the valuation gap has closed, explaining at current valuations, European equities look close to fair value, which means that earnings growth becomes even more important.
Earnings
Which brings us to the second part of the puzzle, earnings growth. One of the major arguments favouring European equities over their US counterparts is the significant gap between US and European earnings.
As Stephanie Butcher, manager of the Invesco Perpetual Pan European High Income Fund explained at Portfolio Adviser’s recent Expert Investor: Europe event, the upside potential present within Europe makes it a more interesting region than the US. And, encouragingly, she added: “We are beginning to see some signs of life in earnings.”
This sentiment is echoed by Royal London European fund managers Andrea Williams and Neil Wilkinson, who, when asked whether or not they were concerned about the possibility of earnings disappointments, told Portfolio Adviser: “what we have seen so far is companies at least meeting expectations and, in a number of cases, beating them, partly because there has been an underestimation of the impact of the weaker euro.”
Wilkinson added, “Company guidance looks fairly conservative still in many cases, but given that we are still relatively early into the reporting season, that is understandable. But, that said, there have been a number of companies raising guidance in the last few weeks.”
Barakos agrees, point out that, after no growth in earnings at all for the last five years, estimates of 5% earnings growth for the region are common and, if one excludes the energy sector, which has been brought to heel by the falling oil price, aggregate earnings estimates rise to 10%.
“If we further strip out other areas struggling with idiosyncratic issues, such as Switzerland grappling with the dramatic Swiss franc appreciation, the estimates climb even higher to nearly 15%. And those estimates continue to be upgraded.”
But, he adds, “As we look for corporate earnings to finally deliver on the improving business landscape, a selective approach to finding the best investment opportunities is critical.”
Thus, it seems that while the smartest money has been in Europe for some time already, there remain good reasons to stick around.
